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Price Wars Caused by Switching Costs

  • Klemperer, Paul

In many markets, consumers have "switching costs" (for example, learning costs or transaction costs) of changing between functionally-equivalent brands of a product, or of using any brand for the first time. The author analyzes a four-period, complete-information model of a market with switching costs in which new entry occurs after the second period. The new entry results, in equilibrium, in a price war. That is, the new entrants' prices are higher in the postentry period than in the entry period, and the incumbent's price falls in either the preentry period or in the entry period and subsequently rises. The author interprets the incumbent's lowering its price in the preentry period as limit-pricing behavior. He distinguishes between two types of price war that can occur, and shows how the type, or mixture of types, that arises depends on the size of switching costs. Copyright 1989 by The Review of Economic Studies Limited.

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Article provided by Wiley Blackwell in its journal Review of Economic Studies.

Volume (Year): 56 (1989)
Issue (Month): 3 (July)
Pages: 405-20

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Handle: RePEc:bla:restud:v:56:y:1989:i:3:p:405-20
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